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2010 Dividend Aristocrats: Dividend Safety Ratings

Statistics updated to reflect current share prices and outstanding shares.

NEW YORK ( TheStreet) -- The investment thesis behind the S&P 500 Dividend Aristocrats -- an index composed of large-cap S&P 500 companies that have increased dividends for 25 consecutive years -- is simple and effective: Increased dividend payouts will compound over time.

For example, a $1,000 investment in a stock yielding 4% -- growing dividend payout 7% annually -- will yield approximately 8% on the original $1,000, 10 years later (assuming no capital appreciation).

This concept is known as "yield-on-cost."

In a perfect world, investors would be able to buy a Dividend Aristocrats ETF, sit back and watch their portfolio appreciate. Unfortunately, things aren't so simple. Every December, Standard and Poor's adds and subtracts stocks from the Dividend Aristocrats index as companies come into and fall out of compliance.

In December 2009, two companies were added to the list while 10 companies were eliminated (notable eliminations include General Electric (GE), Pfizer (PFE) and US Bancorp (USB)). For an individual investor mimicking the index, losses will almost certainly be realized with every eliminated security.

A cautious investor should use the Dividend Aristocrats index only as a starting point for dividend stock ideas -- paying careful attention to the financial condition and prospects of each company.

In the past, we have suggested that income investors periodically subject their portfolio to a " Dividend Acid Test*" -- a pass/fail exam that indicates if a company's dividend payout is covered, in full, by the company's liability adjusted cash flow yield (LACFY).

Of course, a failing grade does not ensure that a dividend cut or elimination is imminent, but rather, that the failed company may have difficulty continuing payouts in the face of operational adversity or a large debt maturity. Similarly, a passing grade offers no guarantee that a company will not face a prolonged hardship or that the company's management will sustain its current dividend policy. Investors must always be cautious.

The following pages contain pass/fail results for 39 of the 42 companies that comprise the 2010 S&P 500 Dividend Aristocrats -- ranked in ascending order by liability adjusted cash flow yield**.

*Pass = Dividend yield less than LACFY, Fail = Dividend yield greater than LACFY

**To determine liability adjusted cash flow yield, a "short formula" was used, defined as:

5-Year Average Free Cash Flow / ((Outstanding Shares x Per Share Price) + (Liabilities - Cash))

Note: In the case of public utilities, "net income" has been used in place of "free cash flow." Insurance companies cannot be valued using a simple cash flow formula -- as a result -- Chubb, Aflac and Cincinnati Financial have been omitted from this list.

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